Chapter 3: Audit Planning l Flashcards
What are the three main phases of an audit?
1) Risk Assessment Phase
2) Risk Response Phase
3) Reporting Phase
Risk Assessment Phase
involves gaining an understanding of the client, identifying factors that may impact the risk of a material misstatement in the financial statements, performing a risk and materiality assessment, and developing an audit strategy.
Risk Response Phase
involves detailed tests of controls and substantive testing of transactions and accounts.
Reporting Phase
Involves evaluating results of detailed testing in light of the auditor’s understanding of their client and forming an opinion on the fair presentation of the client’s financial statements.
Gaining an Understanding of the Client
Understanding the client in detail to be able to assess both entity-level risks and financial statement accounts that require closer examination:
- Understand the nature of the entity’s business and typical transactions.
- Major customers & suppliers (quantity, integrity, ability to pay)
- Staff component/management makeup
- Understanding of structure - financing, ownership
- Industry level understanding - positioning in the market, risks, reputation
What are the two types of Fraud
1) Financial Reporting Fraud
2) Misappropriation of Assets Fraud
Financial Reporting Fraud
- Improper asset values, unrecorded liabilities
- Delaying expenses, bringing forward revenues
- Delaying revenues, bringing forward expenses
- Fictitious revenues, understanding expenses
Inappropriate application of accounting principles
Misappropriation of Assets Fraud
- Theft of cash by employees
- Using company credit card for personal items
- Failure to remove ex-employees from payroll
- Unauthorized discounts or refunds to customers
- Theft of inventory or other assets
What are the three parts of the fraud triangle?
1) Incentives and Pressures
2) Opportunity
3) Attitudes and Rationalizations
What are some incentives and pressures that clients may make them feel inclined to commit fraud?
- Competitive pressures, falling demand, falling profits, threat of takeover or bankruptcy.
- Pressure to meet market expectations, plans to list on stock exchange or negotiate loans.
- Remuneration tied to profits (e.g. bonus, options).
- Personal Financial Obligations.
What are opportunities for fraud to be committed?
- Accounts that rely on estimates and judgement.
- Complex or unusual transactions.
- Significant adjusting entries and reversals after year end.
- Poor corporate governance, poor internal controls.
- High staff turnover.
- Lack of mandatory vacations for employees performing key control functions.
- Large cash on hand amounts.
- Inventory that is small in size, high in value, or in high demand.
Attitudes vs. Rationalization
Attitudes are ethical beliefs about right and wrong whereas rationalization refers to ability to justify an act.
What are some examples of rationalization?
- Poor tone at the top.
- Poor attitudes towards internal controls.
- Excessive focus on maximizing profits/share price.
- Poor attitude to compliance with accounting regulations..
- Changes in behaviour or lifestyle.
- Tolerance of petty theft.
- Rationalization that other companies “do it too”.
Seven indicators (red flags) of possible frauds
- Key finance personnel refusing to take leave.
- Poor compensation practices.
- Complex business structure.
- No, or ineffective, internal audit.
- High turnover of auditors.
- Unusual transactions.
Weak internal controls.
Going Concern Risk
justifies valuing assets on basis they will continue to be used in business and liabilities paid when due.
